The Future of Blockchain and NFTs
First Citizens Bank (Bank) currently stands neutral on all cryptocurrencies and non-fungible tokens, or NFTs. The Bank doesn't offer or incorporate any cryptocurrency or NFT as part of any investment strategy or model, nor does the Bank endorse the purchase or sale of any cryptocurrency or NFT. Regardless, there's great interest around this subject, and we want to provide information on the long-term financial implications. Please understand that the information in this article is for educational purposes only and shouldn't be considered as advice. If you currently hold or are considering purchasing cryptocurrency or NFTs, we recommend that you speak with a tax professional.
In March 2021, Christie's sold an NFT called, Beeple's Everydays: the First 5000 Days, for $69 million. Many of us heard that news and wondered what an NFT is. And moreover, who would pay that much for one?
There are times when a new phenomenon explodes into the cultural zeitgeist and it leaves you feeling bewildered and confused. While NFTs are still a growing and changing field, we can explain the groundwork and discuss some trends for where they may be heading.
What is an NFT?
An NFT, also known as a non-fungible token, is a unique piece of data or digital asset, like a video or photo file. Unlike a dollar bill, where one bill is valued the same as any other, an NFT is distinctive and isn’t interchangeable. Think of things like collectible baseball cards or vintage cars which are each unique and valuable—only instead of the item being a tangible object, it's virtual or digital.
The token aspect of the name refers to the format in which it's distributed. If you refer to our article, Taxation of Cryptocurrency, we gave an overview of blockchain, the digital ledger or chain of transactions that make up the history, verification process and ownership process for a cryptocurrency like Bitcoin or Ether. When a system such as a cryptocurrency or NFTs operates on a blockchain, it's called a token. The Ethereum blockchain is the process or structure on which the majority of NFTs are bought and sold.
To understand NFTs, it helps to revisit the mechanism of blockchains, which were initially designed as the process for cryptocurrency, in a more expansive light. In this infographic, we explore how the blockchain process works, from transaction request to completion.
How the blockchain works
- Transaction requested: A person creates a virtual wallet (an account funded with cryptocurrency using a software application) and requests a transaction.
- Transaction broadcasted: The transaction is broadcast to a network of computers called nodes.
- Transaction validated: The node network validates the transaction and the user's status using known algorithms.
- Transaction confirmed: A person or group uses computers to solve the algorithm and confirm the transaction. These are called miners, and they may be compensated for their work.
- Transaction is added as block in the chain: After confirmation, the transaction enters as a block in the chain of data along with other transaction blocks that make up the blockchain.
- Transaction completed: The original person requesting the transaction now holds the digital currency and is referred to as a hodler or is engaged in the act of hodling.
Blockchain is at a crossroads
Today, the future of cryptocurrency is unclear. Cryptocurrencies have significant market capitalization to date, as much as $1.9 trillion for all types combined. When you consider that Apple and the US Dollar are each at $2.1 trillion of capitalization, it's clear that cryptocurrencies are an emerging asset class.
The prognostication for the future of that asset class falls into two camps, the proponents and the detractors.
Proponents cite several characteristics that signify the optimistic value proposition of cryptocurrencies and explain their future growth.
- Because blockchain is built on a decentralized and democratized peer-to-peer system, it appeals to the distrusting consumers and investors who were left in financial institutions and governments after the Great Recession
- Given its virtual nature, the blockchain is a global system and thus transcends the borders and limitations of individual countries
- Blockchain is anonymous and secure
Detractors of cryptocurrencies look to several factors that indicate the speculative nature of cryptocurrencies.
- The immutable and irreversible nature of the blockchain—once a transaction is recorded it can't be changed. The decentralized and distributed nature of the blockchain means making changes to ledger process isn't easy even if it's beneficial to all parties.
- The energy costs from computer power and carbon taxes needed to verify a transaction has increased to the point of putting cryptocurrency in a precarious position when prioritizing climate change and ESG factors. The total electricity used for the Bitcoin network is equivalent to Argentina's annual electricity use. Yet Bitcoin transactions account for just 0.02% of the world's 750 billion cashless transactions.
The future of cryptocurrency is at a crossroads. However, it's helpful to consider the system upon which it's built separately, because the blockchain itself has a more diverse array of applications and brighter future than that which is limited to cryptocurrencies.
Blockchain technology as an industry disrupter
As described above, blockchain has many desirable features. It's a decentralized, peer-to-peer, authority of data that allows exchange of data, which is passed along in a secure, encrypted format, and requires the owner's permission to access or transact the data.
Considering these features, coupled with a generation's distrust of government, industry and big finance, there are numerous industries that can be reimagined utilizing the blockchain as a more efficient process that eliminates the middleman or regulatory oversight. Some examples of uses of blockchain for functions other than cryptocurrency include the following.
Contracts can be created and housed on the public ledger of a blockchain. They would be automatically executed based upon specific criteria or provisions.
Smart contracts could have wide ranging applications. Examples range from house buying, purchasing a car, long-term service contracts such as for phone or security services, to selling a business or negotiating an employment contract.
The prominent features of blockchain include its recordkeeping capabilities, along with its security. Thus, in any transaction where recordkeeping is necessary, blockchain is effective.
Examples of recordkeeping include deeds or titles for real estate, trade settlement, student grades and performance. Passport applications or other identification are additional examples.
Certain government functions need to take place in a secure verifiable way, such as voting. If the voting process were conducted via blockchain, it would ensure that votes would only be counted once, and rapid ballot processing could occur on a verifiable open-to-read network.
Examples of government applications include elections and the voting process, voting by legislators to enact laws and border control processing.
Non-fungible tokens (NFTs)
Many people like to collect things, such as baseball cards, or artwork. What if you were able to collect digital items or digital representations of items? That's basically what some NFTs represent—a collectible asset.
Any digital item such as a photograph, a tweet, an image of artwork, a video of dancing or a sports move can be an NFT. But NFTs have far greater potential impact and application than just being a digital baseball card.
The popularity of current NFTs
Most of the excitement around today's NFTs are in the collectibles category, especially in digital art and sports videos. While any blockchain can implement a version of NFTs, the majority of the NFTs sold and traded today are done as tokens on the Ethereum blockchain. New industries are popping up every day to market NFTs. One of the biggest is NBA Top Shot, a blockchain company founded in July 2019 that serves as an online forum for trading virtual basketball cards and video clips of popular players. The clips, or moments, are sold as tokens, making them non-fungible, secure, and difficult to counterfeit, with the token acting as provenance for the video. Top Shot sells them in bundles or as a single rare moment in a game that can sell for hundreds of dollars. The company has grown from a trading forum for a few hundred users to hosting some eye-catching catching transactions like a highlight of LeBron James recreating a famous Kobe Bryant dunk that sold for $387,600.
Similarly, CryptoPunks—a project selling 10,000 digitally generated unique artwork characters—were one of the first NFTs available for sale on the Ethereum blockchain. Their highest sale as of June 2021 was for $11.7 million.
Why are NFTs generating such high sales? You can't hold them in your hand. Moreover, you don't necessarily own the copyright or exclusive right to the image or video. So, what's the appeal?
Like any collectible there's the emotional satisfaction of collecting. However, unlike a baseball card that you purchased and put in a box and never touched or shared for fear of damaging it and reducing its value, you can share and post your NFTs as much as you like. You also get the satisfaction of knowing only you own the original NFT. And beyond collecting, NFTs generate a new avenue for income.
Recently, the Supreme Court ruled against the NCAA's rights to bar college athletes from getting paid. This ruling opens the door to collegiate athletes to engage in marketing deals, but only a few of the top college athletes will get endorsement deals. Those leftover may be able to monetize their abilities by selling digital videos or images of themselves and their work as NFTs. Further, female athletes—who have fewer opportunities to go pro after graduation due to the lack of pro women's leagues (and which often pay less than the men's leagues)—could also leverage NFTs to open new profit.
Artists are another group that could leverage NFTs to monetize their work, especially those whose work is fleeting, such as tattoo artists who are paid for their time and whose best work is limited to the body part of one individual. A digital image of that tattoo could be sold as an NFT, giving the tattoo artist further opportunities to make money off their creativity.
There are other reasons why NFTs are exploding in popularity. After a year of most of us being secluded at home due to the pandemic, many of us realized we got significant time back by not commuting and being more efficient at home, leaving time to explore new creative talents. NFTs are one way in which everyday creators have sought to earn income by taking control of their careers and staying home.
NFTs may also be a reaction to the transience of the web. Images or tweets that have worldwide impact as a meme often generate no dollar benefit to the writer or subject of the photo. But by selling the image as an NFT, the owner may be able to not only finally receive some compensation for the item, but also add a level of permanency to a tweet or image that would otherwise fade as a flash moment.
An artist who sells her work as an NFT can also use smart contracts to require royalties—as much as 10%—on any future sales of the NFT. This is a major difference from traditional art sales where artists don't share in any resale proceeds and creates an ongoing future stream of income for the artist.
The Future of NFTs
There are many more marketplaces that have been created around the buying and selling of NFTs besides Top Shot, including OpenSea, Rarible and CryptoKitties. There are even several sites that monitor the NFT marketplace, including CryptoSlam! and Nonfungible.com. The immediate future of NFTs revolves around collecting—especially art—and is likely to expand into music. But NFTs could easily take a turn into a new arena, such as authentication.
For example, Nike recently patented a method called CryptoKicks to verify the authenticity of sneakers by using NFTs. The sneaker is sold with a digital representation of the shoe and is linked to the buyer as a cryptographic token. When the shoe is resold, the token accompanies the trade. Considering that the counterfeit sneaker market is $450 billion, utilizing NFTs to create provenance and prevent fraud could signal a tangential turn in the future of NFTs—not just for the sneaker market, but for any item subject to counterfeit or fraud such as designer handbags, sports memorabilia and more. Attaching an NFT to these items creates a clean transaction history back to the original that circumvents counterfeiting.
Moreover, with NFTs, many of the middlemen needed for a transaction—such as lawyers and escrow agents—are no longer necessary. Engaging in any transaction, whether a buy sell, or employment agreement using NFTs may reduce the need for additional advisors who ensure the integrity of the transaction because the NFT or blockchain will perform that function.
Lastly, as augmented and virtual reality technology matures, people are going to spend more time and money in virtual environments. Currently, you can earn and purchase in-video game NFT items for your avatar or characters such as gear, protection devices or any other item that serves to move the game's progress or story forward. The future of the in-game purchasing world is only set to expand substantially as game assets can be monetized. Users may even one day be able to work and earn money through their work in their avatar's careers in a virtual game, rather than in the real or brick and mortar world.
What does this all mean? In short, be ready for change. NFTs are going to change the way we determine and validate ownership of our collectibles, art, property and more. NFTs are going to empower an artist to go from local to international, and to benefit from their work through multiple owners as their works are bought and sold in the future. They'll also change the income opportunities for college athletes, song writers, content providers and so many more. NFTs could very likely replace many middlemen we currently rely on for transactions and contracts thus reducing costs, assuring accuracy and honesty, and creating efficiency.
Although NFTs have been around for years, we're still in the early chapters of the NFT story. Every day, people across the globe are working on ways to digitize, monetize and build upon the current technology and use cases for NFTs. Whether you are a consumer, creator, spectator, or early adopter, take the time to learn about NFTs as they'll soon be a part of our everyday personal, business and entertainment lives for years to come.
A few financial insights for your life
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